Friday Look Ahead: Washington Will Call the Shots for Markets

Washington will call the shots on Wall Street Friday as traders weigh the risk of unforeseen developments in the debt talks over the coming weekend.

Wall Street

Several Dow 30 heavyweights—Caterpillar, General Electric, Verizon and McDonald's—report before the opening bell and could influence early market direction. Another Dow component, Microsoft reported after Thursday's bell, and was lower in after-hours trading even after it beat earnings estimates.

Stocks and other risk assets rallied with the euro Thursday, as European leaders struck a debt deal to help Greece. The Dow was up 152, or 1.2 percent to 12,724, and the S&P 500rose 17, or 1.4 percent to 1343.

The euro rallied hardand was up 1.3 percent to 1.44 in late New York trading. European leaders agreed on a plan that would cut Greece's debt burdenand clear the way for a 109 billion euro (US$150 billion) financing plan. Under the plan, private investors would be encouraged to exchange their bonds for new bonds, which could have a maturity of up to 30 years.

Markets also reacted to headlines from Washington Thursday and were sensitive to various reports about progress between the White House and Republicans that could lead to a debt-ceiling vote. The markets, however, are becoming at the same time even more anxious, as the Aug. 2 deadline to raise the debt ceiling gets closer.

A report from Standard and Poor's on what would trigger a downgrade of the U.S. credit rating made the rounds, reminding traders that S&P could cut the credit rating even if the U.S. raises the debt ceiling but does not take satisfactory steps to reduce its deficit. S&P put the possibility of a downgrade at 50/50.

"Now the spotlight turns to Washington, and the light is going to shine brightly. The Europeans got their act together for the time being, Friday was the drop-dead date and now it's not a drop-dead date. If the market doesn't see any significant progress here, this type of complacency may begin to evaporate," said Boris Schlossberg of GFT Forex.

"I think as we approach the weekend with no resolution in sight, the markets are going to get considerably more cautious. Any rally in risk will be capped," he said.

Jack Ablin, CIO of Harris Private Bank, said Thursday that he's slightly less convinced that Congress will raise the debt ceiling in time. He now sees a 20 percent chance that it does not, from a previous view of 5 percent.

Ablin said if the debt ceiling does not pass, the calamity would ultimately create a new buying opportunity in stocks. "As 12- to 18-month investors, we're willing to look past the valley and to the other side. If we get hammered, we're going to look at this as a buying opportunity. This is the biggest contrived crisis we've ever seen. It's not that we don't have the ability to pay, there's just not the willingness," he said.

As for Thursday's rally, "This was for euro resolution, but even still we're on the path to earn $25 a share (for the S&P companies) this quarter. A hundred and some odd companies reported, and 75 percent of them have beaten. We're up from $23 per share last quarter. We're now at a $100 per share (12-month) run rate, which with the S&P forward earnings (p/e) at 13.4, we're at a 15 to 20 percent 'distrust' discount," he said. "Investors just don't trust the stock market."

As stocks rose, Treasurys sold off Thursday and the 10-year yield rose back above 3 percent. "We're going to continue to trade off of these headlines. If we get a solid response out of Europe tonight suggesting the European deal is done and it's endorsed by the markets, I suspect the U.S. (markets) will follow suit until it starts in to trading off of headlines on a potential U.S. deal," said Ian Lyngen, senior Treasury strategist at CRT Capital.

"It feels as though the politicizing of the budget debate has been a process of letting the politicians politic openly for the benefit of their constituencies, but we're nearing the point where the heavy weights in Washington are likely to say: 'listen, you had your moment in the limelight and now there's something that needs to be done because now it's at this point where it gets irresponsible,'" Lyngen said.